Central-Bank Gold: Joining the Dots

Yes, central banks are holding more gold. But they're holding very much
more wood-pulp on top...

The gold price on Wednesday broke up through the downtrend starting at last
summer's record high. Or so a technical analyst studying the price chart would
tell you.

But just as in late 2007 - from where gold began a 55% run inside 6 months
- this week the price of gold
bullion jumped on news that is fundamental: the price of money, specifically
Dollars, the world's #1 currency for trade and central-bank reserves.

Back in 2007, the catalyst came as a baby-step rate cut of 0.25%, signaling
the Fed's switch from raising to destroying the returns paid on cash savings.
Now the Fed's new zero-rate promise "took gold comfortably clear of the 50,
100 and 200-day moving averages, and opened up some big targets to the upside," says
one London technician. The previous ceiling of $1700 has become a support level
according to bullion bank Scotia
Mocatta, "with further key support at the 200-day moving average at $1645."

Whatever you make of such numbers, it's worth stepping back to see the wood
for the trees. Because the trend in who's buying
gold, and why, is so plain to spot that you hardly need join the dots.

Gold bullion holdings
amongst the world's central banks, for instance, have risen to a 6-year high,
according to data compiled by the International
Monetary Fund. Emerging and developing nations have swollen their gold
reserves 25% by weight since 2008. The debt-heavy West is a net seller, but
only just.

"There's a perception perhaps that gold is no longer a crucial part of the
financial system in the way that it was under the Gold Standard before 1970,
1971," as Marcus Grubb of the World Gold Council put it in an interview with Tekoa
Da Silva this week. "But in fact that's not really true.

"Because even with the ending of the Gold Standard, gold remains as an asset
held by the world's central banks...and you've seen a trend recently for gold
to become more and more a part of the fabric of the financial system."

A good chunk of this weaving is due to official reserves. But as our chart
shows, central banks control a shrinking proportion of what's been mined from
the ground. A far greater tonnage of gold again is finding its way into private
ownership, and there - as Marcus Grubb notes - it's having a greater still
impact on how money and finance work.

First, private individuals have led the rediscovery of gold as
a financial asset, rather than the decorative store-of-value it had become
by the close of the 20th century. So now, China's giant bank ICBC for instance
is holding gold for the "accumulation" savings of 2.3 million citizens, a program
developed in partnership with the World Gold Council. Also the WGC
partners with BullionVault, amongst several other private-investor providers
worldwide. But institutional finance is catching on, and gold is now in front
of the Basel
Committee on global banking, proposed as a "core asset" for banks to hold
- and count as a Tier 1 holding - for their liquidity requirements.

After all, turnover
in London's bullion market, center of the world's gold trade, is greater
at $240 billion per day than all but the four most heavily traded currency
pairs worldwide. So its liquidity is barely equaled. Turkey's regulators
already acknowledged physical gold bullion as a Tier 1 asset for its commercial
banks starting in November, with the cap of 10% worth some 5.5 billion Lira
($2.9bn) according to Dow
Jones. And a growing number of investment
exchanges, meantime, as well as prime brokers, now accept gold as collateral,
posted as downpayment by institutions against their commodity and other leveraged
positions.

Gold bullion pays
no interest of course. But in our zero-yielding
world, that only puts it ahead of where the capital markets are being herded
by central-bank policy anyway. Nor does gold have much industrial use (some 11%
of global demand in the 5 years to 2011), a fact which highlights its unique "store
of value" attributes. Being physical property, gold is no one else's debt to
repay or default. Being globally traded, it's deeply liquid and instantly priced.
And being both rare and indestructible, it couldn't be any less like "money" today.

Scarcely a lifetime ago, gold underpinned the globe's entire monetary system.
Outside China, which tried sticking with silver, the compromised and then bastardized Gold
Standard which followed first World War I and then World War II still saw
the value of central-bank gold reserves vastly outweigh the paper obligations
which those banks gave to each other.

Even three decades ago, 10 years after the collapse of what passed for a Gold
Standard post-war, central-bank gold holdings still totaled some three times
central-bank money reserves by value. But look at the decade just gone - the
10 years in which gold
investment beat every other store of value hands down. Pretty much every
currency you can name lost 85% of its value in gold. Yet the sheer quantity
of new money pouring into central-bank vaults saw their gold holdings only
just hold their ground.

Gold's rise, in short, has been buried under wood-pulp. To recover its share
of central-bank holdings as recently as 1995 would now require a further doubling
in value. To get back to the 1980s' average would require a 15-fold increase.
Or, alternatively, a 93% drop in the value of foreign currency reserves relative
to central-bank bullion holdings.

Such a trend is not yet in train, neither on the charts nor the fundamentals.
The US Dollar remains the biggest reserve currency, weighing in at 62% of stated
reserves according to IMF
data, down from its peak above 71% in 2001 but more than equal to its share
in the mid-1990s. Even so, as former FT columnist and current capital-markets
editor at The Economist Philip Coggan writes in his latest book, Paper
Promises:

"If Britain set the terms of the Gold Standard [1870-1914], and America set
the terms of Bretton Woods [1944-1971], then the terms of the next financial
system are likely to be set by the world's biggest creditor - China. And that
system may look a lot different to the one we have become used to over the
last 30 years."

Coggan rightly notes that China isn't the only large creditor, and nor does
it hold anything like the dominance which the US held at the end of World War
II. But whether this switch starts today or only starts to show 10 years from
now, such a change of direction can't be discounted to zero. Repudiation of
government debt - the form which most foreign currency reserves take - will
only begin with the Greek bond agreement, perhaps leading first to a rise in
US Dollar holdings but also highlighting the ultimate risk of paper promises.

That fear, of having to write off money in default or devalued, is already
driving the rise in central-bank gold purchases.

Formerly City correspondent for The Daily Reckoning in London and head of
editorial at the UK's leading financial advisory for private investors, Adrian
Ash is the head of research at BullionVault,
where you can buy gold
today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

About BullionVault

BullionVault is the
secure, low-cost gold and silver exchange for private investors. It enables
you to buy and sell professional-grade bullion at live prices online, storing
your physical property in market-accredited, non-bank vaults in London, New
York and Zurich.

By February 2011, less than six years after launch, more than 21,000 people
from 97 countries used BullionVault,
owning well over 21 tonnes of physical gold (US$940m) and 140 tonnes of physical
silver (US$129m) as their outright property. There is no minimum investment
and users can deal as little as one gram at a time. Each user's unique holding
is proven, each day, by the public reconciliation of client property with formal
bullion-market bar lists.

BullionVault is a
full member of professional trade body the London Bullion Market Association
(LBMA). Its innovative online platform was recognized in 2009 by the UK's prestigious
Queen's Awards for Enterprise. In June 2010, the gold industry's key market-development
body the World Gold Council (www.gold.org)
joined with the internet and technology fund Augmentum Capital, which is backed
by the London listed Rothschild Investment Trust (RIT Capital Partners), in
making an $18.8 million (£12.5m) investment in the business.

Please Note: This article is to inform your thinking, not lead it.
Only you can decide the best place for your money, and any decision you make
will put your money at risk. Information or data included here may have already
been overtaken by events - and must be verified elsewhere - should you choose
to act on it.